FinTech and payment methods in Brazil – challenges and opportunities

July 2017 | EXPERT BRIEFING | BANKING & FINANCE

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Victor Hugo once wrote that one cannot resist an idea whose time has come. That certainly seems to be case with the revolution promised by FinTech and alternative payment methods when we look at the current developments in Brazil. The celebrated ingenuity of Brazilian entrepreneurs, coupled with the sophistication of our financial system, has created ideal conditions for a vibrant environment – one in which entrants are creating solutions with the potential for global expansion if they survive the demanding settings and fierce competition seen in the country’s financial markets. A recent report from Goldman Sachs estimates that Brazilian FinTechs should generate a potential revenue pool of about $24bn in the next 10 years, which justifies the optimism from local entrepreneurs and foreign investors.

Brazilians like to believe they are especially resilient when it comes to facing financial crises. The premise is undoubtedly true when we look at the country’s major banks. Following crashes in the 1980s and 1990s, banking regulation and controls became robust enough that our financial sector went through the 2007/08 meltdown relatively unscathed, with banks in much better shape than most of their foreign counterparts. Such a level of stability and control, of course, came at a price: opening a financial institution in the country requires a thorough plan and some patience and meeting the regulation standards takes its toll.

The regulatory structure naturally led to a heavily concentrated sector, in which the five major banks hold around 84 percent of total loans and 90 percent of retail branches, but at the same time they have not been able to grant access to a substantial portion of the Brazilian population: estimates indicate that nearly 35 percent of people above the age of 18, representing around $200bn in financial transactions, do not have a bank account. Even with such a low level of access to financial services, there are more than 100 million valid cards in circulation in the country, with over 12 billion transactions in 2016 totalling approximately $300bn. Other indicators corroborate what those numbers show: Brazil is one of the most interesting places to invest in financial solutions and products.

The notoriously conservative Central Bank of Brazil has taken several steps in recent years to change the existing scenario and open up the market. In 2011, it authorised banks to offer exclusively digital accounts to their clients, reducing costs and bureaucracy. A set of rules in 2013

established the regulatory framework for different payment methods, putting forth clear procedures and guidelines for payment arrangements and payments institutions (issuers of e-currency, issuers of post-paid instruments and acquirers, etc.). In 2016, clients were authorised to open bank accounts remotely, without actually visiting a branch of the respective bank. These and other norms have had a very positive effect not only in terms of the market’s perception with respect to the Central Bank, but also in inducing the appearance of new players in areas that seemed averse to innovation. The regulator’s pro-business spree seems to continue: legislation is under discussion to deal with different aspects of cryptocurrencies, blockchain, digital wallets, P2P lending, robo-advisers, crowdfunding and the exchange market, with a possible regulatory sandbox in sight to encourage growth.

This favourable legal framework has contributed to the boom in FinTech companies in the country. A report from FintechLab that covered 54 companies in 2015 lists 244 companies in the ecosystem in 2017, acting in payments, financial management, lending, investment, funding, insurance, debt renegotiation, cryptocurrencies, DLT, foreign exchange and other services. The same report shows 158 companies in Mexico, 77 in Colombia, 60 in Argentina and 56 in Chile, demonstrating Brazil’s leading role in Latin America. From the 244 covered companies, 72 percent have already received funding from third-party investors. Two of them have also been included in KPMG’s 2016 Fintech100 among the most disruptive in the world – Nubank and GuiaBolso. Nubank, which offers credit cards and other financial services, is an interesting display of the market’s potential: often cited as a strong candidate to become Brazil’s first unicorn, the company has raised nearly $200m from heavy-hitters that include Sequoia Capital, Tiger Global, Founders Fund, Kaszek Ventures and QED Investors.

The flexibility and originality of Brazil’s FinTechs can be seen when we look deeper into different niches of the financial industry. New companies focused on lending are concentrating on segments largely left aside by regular banks, offering loans at lower costs after the traditional institutions restricted their credit offers and increased interest rates. Most FinTechs are proposing rates between 80 percent and 100 percent per year for unsecured loans, whereas banks present an average rate of nearly 140 percent for direct credit and over 300 percent in the so-called cheque especial, which is the pre-approved line a customer can automatically resort to when their checking account falls below zero. Other entrants adopt a model closer to the one employed by large banks: Creditas (which has RedPoint e.Ventures, Quona Capital, QED, Kaszek Ventures, IFC and Naspers as investors) offers loans to customers who can provide some form of collateral, with rates as low as 20 percent or less of those charged by banks.

All such companies, however, have in common the fact that their legal structure involves some form of collaboration with traditional banks, which are the institutions formally authorised by law to grant credit to the public. Normally, the bank is the actual issuer of the note, while the FinTech manages the other aspects of the loan and its collection. This need for cooperation may not last long, since the Central Bank has announced it intends to issue a rule specifically directed at lending FinTechs to simplify their operations. Similar creativity can be found in companies focused on P2P lending, for the same regulatory reason, and with a matching solution: collaborating with a financial institution.

At the same time, the market for traditional payment methods shows increasing sophistication and competitiveness, with reduced entrance barriers and an open field for those interested in investing. Central Bank rules and decisions from the Brazilian antitrust authorities with respect to acquirers are gradually levelling the playing field in an already diverse environment. Up until 2010, Cielo and Rede were the exclusive operators of Visa and Mastercard, respectively, which was a powerful deterrent to any incoming contender. After the exclusivity was dropped and with the portability of acquirers enacted in 2013, different companies, such as Stone, began to take sizeable portions of the market.

A recent agreement between Itaú, Rede, Hipercard and the antitrust authorities also terminated the exclusivity between Hipercard and Rede and forced Rede to insert the cryptographic keys of competing acquirers in its pinpads (prior to that, Rede only exchanged keys with Cielo, leaving out the smaller competitors). Similar agreements may soon be implemented with respect to other major issuers and acquirers, creating an even better environment for entrants. A further indicator of the increased competition is that Banco Safra, one of the major private banks, has just launched its own acquirer.

With so many developments, one could wonder if the major banks are simply watching by as mavericks come into town with their guns blazing. Instead of a gunfight, we are seeing banks acknowledging that change is inevitable and that it is better to be a part of it than to swim against the tide. Bradesco launched in 2014 its InnovaBra programme in order to get closer to startups focused on the financial market, and recently created InnovaBra Ventures, a corporate venture capital fund with several investments under its belt already. In the last couple of years, Santander purchased the acquirer GetNet and prepaid issuer ContaSuper, and has just launched a payment FinTech called Superdigital. Itaú Unibanco structured with Redpoint e.ventures a co-working space in São Paulo, CUBO, in order to become a reference in entrepreneurship and innovation, and its current acquisition of 49 percent of XP Investimentos for nearly $2bn shows its willingness to invest in digital channels. BTG Pactual also launched a digital platform to attract the high-level retail clientele, BTG Pactual Digital, with promising results so far.

The creativity and speed shown by entrepreneurs and investors is set to continue, although there are certainly risks that FinTech and payment methods companies need to be aware of when drawing up their plans. The Central Bank’s apparent modern and collaborative approach towards the new market sometimes shows worrisome inconsistencies, such as when it hinted at reducing the term credit card operators have to transfer funds to merchants from 30 to two days – which would have been a fatal blow to Nubank’s business model, for instance. The regulators backpedalled and many investors and observers let out a sigh of relief, but it served as a wakeup call to those who had forgotten the power banking regulations have over businesses in the country. Speaking of challenges, Brazil’s political scenario also continues to follow its House of Cards meets Kafka plot, and predictability should only come after the 2018 presidential elections. In the meantime, we will continue to confirm our resilience to crises, and those more willing to take risks now will profit greatly when the turbulent waters are left behind and this giant is back on its feet.

Bruno Ramos de Sousa is a senior associate at Veirano Advogados. He can be contacted on +55 21 3824 1359 or by email: bruno.sousa@veirano.com.br.